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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures. Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions. Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

Classic: Using Investment Advice, Part 1

I am republishing some old pieces from my days at RealMoney during this busy time that I am in. If there are significant changes in my opinion since it was first published, I will spell out the changes. As for this series, there are none.

Advice bombards all investors. Some is good, some is bad, and much of it is indifferent. In this three-part column, I’ll show how to use the advice you receive so you can be a more effective investor. In analyzing any advice, investors have to consider the adviser, personal character issues, and the nature of the investment proposed. In Part 1 today, I’ll focus on the adviser.

Sought-After Qualities

The first issue is always one of trust: Do you trust the competence and business ethics of the adviser? No one is perfect, but has the adviser made sound decisions in the past in areas similar to where the adviser is proposing advice now? What’s the adviser’s track record? If he’s a professional, does he have a clean record with the regulators and his current and past clients?

Even if the adviser has a great track record, did he get it accidentally? In a past job, I had the fun of interviewing a large number of money managers. We had a need for a large-cap growth manager, and our manager adviser brought in a manager who had a stellar, though short, track record.

The principal of the growth manager was a former pro athlete who had developed an entirely quantitative, momentum-driven management method. The presentation was short, and I asked a few questions about earnings quality and how the process might do in nongrowth-driven markets. I received a very terse set of “we can do no wrong” answers.

After the presentation ended, I pointed out three companies in their portfolio that I knew had weak earnings quality. They politely blew me off. I wasn’t impressed with their processes, and my colleagues were not impressed with their demeanor. Then I had my accident; the next week, two of the companies I pointed out blew up. Their accident followed soon after, which was a significant loss of assets under management. The accident of their prior performance evaporated. Persistent good performance happens for the reasons that the adviser specifies in advance, not by accident.

Even if the advice giver is competent and ethical, what incentives does he have in the situation? Full disclosure allows you to decide whether the adviser’s judgment might be shaded by other concerns. Then you can take that into account in making your decision.

Is the adviser cocky? In my experience, pride goes before a fall. One way to measure this is to see whether the adviser admits to errors. The best advisers admit fallibility, and even try to reduce your expectations. You want realistic advice from someone you can trust. Big claims may draw some clients in the short run, but in the long run, clients are kept through dependability.

Next time, in Part 2, I’ll examine how your character affects how you evaluate the investment advice you get.

About David Merkel

David J. Merkel, CFA, FSA, is a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited David to write for the site, and write he does — on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better.
David is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm.
Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.
His background as a life actuary has given David a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that David will deal with in this blog.
Merkel holds bachelor’s and master’s degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth. View all posts by David Merkel →